Private Equity and Growth Equity Investing in B2B Software and Services Companies
December 13, 2022
In this episode of Private Equity Dealbook, Elana Margulies Snyderman, Director, Publications, speaks with Dan Raynor, Co-Founder and Managing Partner of Argentum Capital Partners, a New York-based growth equity firm that partners with bootstrap entrepreneurs focused on B2B software and services companies. He shares his outlook for investing in those sectors, how if at all higher interest rates and the strong U.S. Dollar has impacted the firm’s ability to finance leveraged equity investments in and bolt-on acquisitions for portfolio companies, how the economy impacted the financial and operating performance of the portfolio companies and more.
Dan Raynor:Sure. Well, you gave a pretty good description of our firm as it is, but as you indicated, we do focus on capital efficient bootstrap companies that have been able to grow beyond that high risk venture stage without raising lots of venture capital. So we seek to be, usually we're the first institutional investor in a company, even though they're five to 10 million in revenues. And our approach is really to focus on those verticals where we have prior investment success and expertise and where we can really help the company grow. The companies we're backing are usually founder-led, and we differentiate ourselves in the market, frankly, by the check size we write. We're investing five to $15 million in companies, and our sector of the private equity market is really now inundated with growth equity firms have raised lots of money, billion dollar plus funds, so their minimum check size has risen to 30, 35 million plus. So we're somewhat differentiated in the market in that we offer a source of capital that is really tailored for those founder-led, bootstrap, capital efficient companies that can scale with modest levels of capital.
EMS:Very interesting, Dan. So it's clear we're in an interesting time in the economy, higher interest rates, a war, a looming recession. I could go on. So based on this, where does Argentum see opportunities that generate an acceptable risk slash rate of return model consistent with your operating guidelines and required limited partner returns?
DR:Yeah. So we still think its great time to invest in companies that are bringing differentiated solutions to the market. What has changed in our market is certainly there's been a valuation reset, and that's taking time for companies to become investors sort of get acclimated to the new valuation environment very quickly. It takes companies a lot longer. And so I think what you're seeing in the space is definitely a slow-down in transactions.
Certainly, the macro environments become more complex. Many people are predicting a recession. So in terms of what we're not investing is we're staying away from cyclical oriented businesses, but still it's really back to the basics for us during a period like this is focus on mission critical solutions that deliver significant returns to their clients. So that's all about reducing costs, particularly in areas such as enabling companies to economize more on the use of labor. Labor's become very expensive. So we're focusing, and we have always invested in companies that are involved in digital transformation. So we love investing in industries that have been slow to modernize, slow to digitize, and they're still relying on older legacy technologies, and we think there are still great opportunities in spite of the environment.
EMS:Absolutely, Dan. So as a follow-up question, like I mentioned, with higher interest rates and the strong US dollar, how would these factors impacted Argentum's ability to finance, leverage equity investments in and bolt on acquisitions for portfolio companies?
DR:So we're not really investing in companies that export and so therefore the strong dollar hasn't really impacted the companies we're looking at. I mean, other than how it's impacted the macroeconomic environment in general in terms of leverage, again, we're not a buyout shop, so we're not leveraging our companies significantly. In fact, we're minority investors, so many of our companies have zero leverage. So now that said, some of our companies pursue buy and build strategies, but again, tuck in acquisitions almost by definition are highly accretive. And the higher cost of leverage really does, again, at the size of the companies we're investing in, the size of the tuck in acquisitions that our companies would be making. It's really not changing things. In fact, it may provide for more a greater supply of companies because those companies who may not be growing significantly understand that in this market, capital is more expensive, and so they may choose to look for a buyer rather than to raise private equity or growth equity to grow in a more valuation sensitive environment.
EMS:And, Dan, as a follow-up question, how has the economy impacted both the financial and operating performance of your portfolio companies as well as your approach to managing and further investing into these companies?
DR:I mean, generally our companies have been doing quite well in the current environment. I mean, there are a few of our companies that are in industries that have been hurt. For instance, we have a couple companies that are selling to mortgage lenders. That industry has certainly been hurt. But on the other hand, the solutions that are offered are actually even more germane now, if you can offer solutions that enable you to originate loans cheaper or process loans inexpensively. So other than specific industries, our companies are doing really well. I mean, I think we are seeing, and others in my business I think are seeing the same thing that sales cycles in many industries are slowing, and I think many companies are preparing for tougher economic times. I think there's some belt tightening that's starting. So for your average enterprise software company, particularly more horizontal applications, I think sales cycles are starting to lengthen a bit, but we're focusing mostly on vertically oriented software companies that are very industry specific. So depending on the industry, it varies.
EMS:Great, Dan, so let's shift gears a little bit and talk about the due diligence process, and given the interesting time we're in with respect to the economy, I wanted you to share your outlook on your due diligence process from all perspectives.
DR:Yeah. I mean, our due diligence process hasn't changed at all. We're going to do a thorough due diligence. That's how we protect ourselves from making mistakes, and that's how we understand our companies better, frankly. I tell a lot of our companies, but when we're making an investment that not only is the due diligence process required for us to validate the investment opportunity and the value we're paying, but it also enables us to really understand their company better and to be a better investor. That said, I have heard in the market, particularly among the more aggressive buyout firms, that due diligence has returned probably nine months ago. Deals were closing in unbelievably short amounts of time. I think what you're seeing is for the due diligence period to length, and again, clearly, if you're leveraging a company, you want to make sure that you're going to have the cash flow to pay that leverage. But again, that's kind of not our market.
EMS:Great, Dan, and as a follow-up to that, what advice or recommendations do you have for emerging companies that are contemplating an exit transaction?
DR:Yeah. Look, again, NASADAQ fallen 40% from its highs. Market's been very volatile. It's been better the last couple weeks, but clearly valuations have come down in the public markets and the private markets have been slower to change, mostly because not that deals are... Less deals are getting done. So I think there's less data points. What I would say to companies is that the A or A+ companies are going to have no problem closing investments on very attractive terms. There's a lot of capital out there and great companies are always great companies. Some of the companies that have a little more hair, a little more of the story, they're going to have bigger challenges in this market. The advice I would raise, and maybe this is a little self-serving, given our investment strategy, but do a smaller raise instead of raising 30 million raise, 10 million, and put more points on the board, and continue your growth, and come back to the market in another year or two when the market improves.
I mean, we're seeing a lot of that where companies are basically reducing the capital they're raising. Also, the market is not rewarding growth at all cost. The market now is rewarding managed growth, profitable growth. And so we've advised all of our companies to really focus on if they're not profitable already, really getting themselves to profitability on a much shorter path.
EMS:Dan, we've covered a tremendous amount of ground today, and wanted to see if you have any final thoughts you'd like to share with us.
DR:One thought I would say is when a company is out looking to raise capital, you're probably going to have several alternatives. What I think is really essential is just like an investor's going to do due diligence on the potential portfolio investment, those companies should do ample due diligence on their investor. It amazes me that more companies don't, we really encourage it. We think it's a great selling point for us, but also it really lets both parties know a lot more about each other. And when you make an investment in a company, it's a marriage. It's not a long term. I mean it's a five-year marriage, a seven-year marriage, a three-year marriage. It's not a lifetime marriage, but you definitely want to know who is investing in your company. You want to make sure that they can add the value they say they can, and you also want to have fun with them because you're going to be spending a lot of time, and if you're not having fun, it may not be worth it.
EMS:Absolutely, Dan. Well, I wanted to thank you so much for sharing your perspective with our listeners today, and thank you for listening to the EisnerAmper Podcast Series. Visit is EisnerAmper.com for more information on this, and a host of other topics. And join us for our next is EisnerAmper Podcast when we get down to business.
Transcribed by Rev.com